European trade associations, including some from the financial markets, have demanded a wide ranging clean-up of EU regulations. If rulemakers are up for that, they could do worse than to sort out the mess governing retail bond investment.
The secretariat of the European Round Table for Industry (ERT) has called for a review of regulations that it argues is a critical to step to navigating the labyrinth of rules encumbering a true single market in the bloc and its goal of a Capital Markets Union.
Regulations have developed over the last few years at pace, so it is no surprise that a side effect of this bulging knot of red tape is that some of its contradictions, even its overreach, will need detangling.
The ERT wants, it says, to identify what purpose the rules are supposed to serve and to check if they do, removing duplication and those that are counterproductive.
The Packaged Retail Insurance and Investment Products (Priips) regulation, which governs retail investment in bonds, is just such a case study in unintended consequences.
Priips was designed to empower retail investors by providing them with a standardised Key Information Document (KID) that is clear and easy to digest.
Paradoxically, Priips KIDs have added another layer of complexity and risk such that issuers now won’t touch them with a barge pole.
It's certainly true that investors can't lose money on a product they can't buy but the intention cannot have been to regulate the it out of existence when a simple prohibition would have done.
For example, the ambiguity about the product scope of Priips, whether or not it includes vanilla bonds and where the line is between ‘packaged’ and ‘plain vanilla’ instruments is blurred, and has created liability risk that has led borrowers to avoid EU retail offerings altogether.
Moreover, the purpose of the KID – to contain sufficient information to allow investors to make an informed investment decision – is incoherent and also capped at three pages.
As the famous Woody Allen joke goes, one diner in a restaurant says to another, "The food here is terrible".
"I know," says the other. "And such small portions."
Between Priips and KIDs, regulations designed to aid retail access to the bond market has erected barriers to it instead.
Obstacles
If the EU wants to streamline its regulations and foster market inclusivity and efficiency, what better time to think about letting its bond issuers and retail investors meet without obstruction than by making Priips a pathway to the market rather than a barrier.
Don't take GlobalCapital's word for it either. The European Banking Authority, European Securities and Markets Authority, and the European Insurance and Occupational Pensions Authority wrote in a joint paper in July 2018 that “it can be recalled that the CMU aims, amongst other things, at increasing direct retail investment within the capital markets. The legal uncertainty regarding the scope of the Priips regulation is leading to unintended consequences that may achieve the opposite.”
Six years on we can say their worries were well-founded.
The statement continued: “These consequences are in turn affecting the liquidity of these markets, and given the very considerable amount of direct retail investment in bonds, has the potential to undermine the intentions of the Capital Markets Union (CMU).”
Amen.
It's high time the EU took a hard look at its bond market regulation playbook, not only for the sake of market inclusion, but for the wider CMU project.
The EU is already looking to revise other regulatory frameworks – sustainable finance, securitization, banking, and so on. Addressing the woes of retail investors is only one more logical step to take – but one that will mark a giant leap towards inclusive European capital markets.